Twenty years ago, cryptographer Nick Szabo imagined a world where human action is completely replaced in the contractual process, and hardware and software will alone handle the full lifecycle of contractual activity.
The humble vending machine is an example of this. For all practical purposes, the vending machine is the entire contractual environment for its transactions. It automates the forming and performance of the contract by taking your coins and dispensing you a can of coke. Any attempt to ‘breach’ this contract by breaking into the machine is prevented because the efforts used to physically break into it to steal a can of coke is disproportionate to the reward received.
What are ‘smart contracts’?
‘Smart contracts’ are contracts embodied in software code and performed automatically. This means that the contractual terms are expressed through a set of instructions or logic that a computer can read, and any data necessary as an input is available in digital form (or at least obtained and verified by ‘oracles’).
Complete execution of ‘smart contracts’, including any transfers of value, occurs immutably (because it sits in the blockchain). It is this integration of the specific contractual terms with a general enforcement infrastructure that makes a ‘smart contract’ smart.
An example: When I want to buy an ebook for my Kindle, I agree to pay $x in return for the digital rights to view the ebook (i.e. a contract). Once I have electronically consented to this purchase, my bank account is debited and Amazon’s computer transfers the ebook to my device. However, the debiting of my account and the transfer of the ebook are machine instructions that are merely executing the human-made contract. If Amazon’s program makes an error and a different ebook is transferred, I can go back to Amazon to get a proper replacement.
However, for ‘smart contracts’, the actual contract is the code instructing the network on what to transfers and when. Everything else apart from the code is just an explanation. Essentially, the former merely a digital representation of the contract, while the latter is the contract.
Can they replace the legal system?
Since ‘smart contracts’ are automatically performed and enforcement is presumably rendered unnecessary, does this mean that lawyers and the entire legal system can be done away with?
Interestingly, this question was tested in the real world only last year. A group of Ethereum developers (i.e. a computing platform on blockchain) created a distributed crowdfunding system called The DAO, which implemented a distributed autonomous organisation where corporate governance and operations were conducted automatically through ‘smart contracts’. Users pledged Ether (i.e. the Ethereum cryptocurrency) in return for tokens to vote on projects to be funded. Organisations seeking funding could sign up and receive Ether if they received sufficient votes. Over $150 million of Ether was pledged in a matter of weeks.
The DAO stated in its terms of service that ‘smart contracts’ on the Ethereum blockchain was the controlling legal authority, and any human-readable documents do not supercede the terms of The DAO code.
Within weeks of the launch, a hacker took advantage of a bug in The DAO code and attempted to steal $60 million worth of Ether. Even though this was clearly an attempt at theft, the hack was executed through a series of ‘smart contracts’ that were valid within the rules of The DAO.
Since the transactions were legitimate from the perspective of the ‘smart contracts’ and these were automatically executed, there was no legal or technical way to recover the funds without undermining the entire system.
Eventually, it was only through the implementation of a ‘hard fork’, which split the entire blockchain into two incompatible paths, that the stolen funds could be returned.
Clearly, from this example, ‘smart contracts’ cannot adequately replace the legal system, because they are blind to the factual circumstances surrounding the contract (illegal or otherwise) which may render a contract void.
But even if ‘smart contracts’ can recognise such vitiating factors, it is incapable of remedying such grievances, which is arguably contract law’s primary task.
‘Smart contracts’ in practice
Despite our best efforts, human enforcement of contracts is still essential in giving proper effect to the contracting parties’ intentions.
As can be seen in The DAO example above, sometimes there are errors in the code used to run the contract.
But even without errors, there are also limits such as the inability to fully reduce human-readable language to machine-readable code. Some contractual terms cannot be expressed through formal logic, because they imply human judgment. A machine cannot precisely assess whether one party has used “best efforts” or “good faith”. Computers also do not have the contextual knowledge or subtle understanding required to resolve any contractual ambiguity.
Other limitations such as the inability to take into consideration illegality, fraud or duress means that contracts which should have been void are performed and ‘enforced’ in real time. The hacking of The DAO shows that ‘smart contracts’ have no check on illegality. This hack was simultaneously valid as an enforceable ‘smart contract’ within the bounds of the software system but invalid as theft in the minds of the contracting parties.
Looking forward
Taking a step back, ‘smart contracts’ is only one example of a larger trend of computerised technologies purporting to displace or replace human decision-making . In various such areas, such as human resources or financial advisory (e.g. the rise of robo-advisors), algorithmic systems are praised for their speed, efficiency and reliability in contrast to mistake-probed and biased humans.
However, it becomes clear that machines and codes too are prone to their own errors and biases, and in fact new challenges such as cybersecurity are also created.
In short, ‘smart contracts’ are useful and will replace certain aspects of human decision-making, but it will never be able to replace the legal system or lawyers. Contract law is nothing if not resilient.
The reports of the death of lawyers have been “greatly exaggerated”.
Law Bytes Asia 